foreign capital implies funds that are raised from foreign investors for investment purposes in development projects of a host country. Any investment flowing from one country to another country is foreign investment. This concept came in 1950s when many capital deficient countries resorted to foreign capital as a primary means to achieve rapid economic growth. Foreign capital can enter the country in the form of: 1. Direct Investment 2. Indirect Investment Also, with time the concept of foreign aid came up. It is nothing but movement of money from one country to another in the form of aid for development.
It flows to developing countries in the form of loans, assistance and outright grants from various governmental and international organizations ADVANTAGES OF FOREIGN CAPITAL 1. It raises the level of investment – Brings in more industries and technology to the country and gives boost to the employment, production and economy of the host country. 2. Helps in upgradation of technology – Foreign investment brings with it the technological knowledge while transferring machinery and equipment to developing countries. 3.
Exploitation of natural resources – A number of underdeveloped countries process huge mineral resources, which awaits exploitation. These countries themselves do not possess the required technical skill and expertise to accomplish this task. 4. Development of basic economic infrastructure – Underdeveloped or developing countries require a huge capital investment for development of basic economic structure as their domestic capital is often too adequate. 5. Improves export competitiveness – A foreign investment can help the host country to improve its export performance.
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This is because of increase in the level of efficiency and the standard of product quality. Also, better access to foreign market further improves the export competitiveness. 6. Benefits the consumers with competitive market – Consumers in developing countries stand to gain from a foreign investment through new products and improved quality of goods at competitive prices. 7. Generates revenue to the government – The profit generation by a foreign investment in the host country contributes to the corporate tax revenue in the latter. 8.
Supplements domestic savings - Less developed countries lack sufficient savings, required for investment in development projects like building economic and social infrastructure. Foreign capital bridges this gap. 9. Employment increases in the host country – As foreign companies come up, they establish their plant in the host country. As a result, employment also increases. DISADVANTAGES OF FOREIGN CAPITAL 1. Countries face severe debt problems – If all the investors who have invested in the host country, pull out their money overnight then the host country comes in debt. 2.
Appreciation of real exchange rate occurs – As more foreign investors invest in the country, the demand for the domestic currency rises. This causes appreciation of domestic currency and hence loss of competitiveness of exports as they become costlier. 3. Chances of inflation – Domestic supply of money increases and if this money is not utilized and absorbed in profitable projects then there is an inclination towards inflation. 4. The economy becomes overvalued – As the investors come in, the money in the economy starts flowing causing unnecessary appreciation in foreign currency. 5.
Domestic market is affected – When foreign investments compete with the home investments, the profits in the domestic industries fall, thereby leading to a fall in domestic savings. 6. There is less contribution to public revenue – As the corporate taxes are comparatively less because of liberal tax concessions, investment allowances, designed public subsidies and tariff protection that are provided by the host government. ------------------------------------------------- TYPES OF FOREIGN CAPITAL There are five major types of foreign capital. They are – 1. Foreign Direct Investment (FDI)
It is a process whereby residents of the source country acquires the ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in the host country. The foreign investors are free to invest in India, except few sectors/activities, where prior approval from the Reserve Bank of India (‘RBI’) or Foreign Investment Promotion Board (‘FIPB’) would be required. The followings activities/sectors requires prior approval of FIPB. a. Manufacture of Cigars & Cigarettes of tobacco and manufactured tobacco substitutes b.
Manufacture of Electronic aerospace and defence equipments c. Manufacture of items exclusively reserved for Small Scale Sector with more than 24% FDI d. Proposals in which the foreign collaborator has an existing financial / technical collaboration in India in the ‘same’ field e. All proposals falling outside notified sectoral policy. The foreign investors planning to set of business in India have two options, either to set up a separate corporate entity in India, i. e. incorporating an Indian company or through unincorporated entity, i. e. Branch Office of the foreign entity.
Incorporation of an Indian company can be possible under the provisions of the Companies Act, 1956. The foreign investors can invest in such Indian company up to 100% of capital depending upon sectoral guidelines prescribed by the Government of India. Under Second Option, a foreign company are allowed to operate in India, subject to conditions and activities permitted under the Foreign Exchange Management (Establishment in India of Branch Office of other place of business) Regulations, 2000, through setting up either of the followings: Liaison Office/Representative Office; Project Office; or Branch Office.
While making entry into any nation, innumerable clearances are to be obtained at the state and district levels. Also, a number of practical hurdles, such as infrastructure bottlenecks have to be overcome. Also, the exit is difficult, in the sense that, archaic labour laws, such as the Industrial Disputes Act, prohibit the closure of any company. ADVANTAGES OF FDI Below mentioned are some of the advantages of FDI. They are very similar to that of foreign capital. 1. Growth and employment 2. Technology and know how 3. Access to goods and services 4. Fill the savings gap DISADVANTAGES OF FDI . Political lobbying – In the past, there have been many instances in which MNCs have resorted to political lobbying in order to get certain policies and laws implemented in their favor. 2. Exploitation of resources – Exploitation of natural resources of a host country is not a very uncommon phenomenon in the case of FDI. MNCs of other countries have been known to indiscriminately exploit the resources of host countries in order to get short run gains and profits and have even chosen to ignore the sustainability factors associated with the local communities and local habitat. . Threaten small scale industries – MNCs have large economic and pricing power due to their large sizes. They do not have much problem with regards to financial capital and can hence resort to using advertising which is a costly affair. Also, these companies are global players who have their operations spread across countries and have effective supply chains which enable them to have economies of scale which smaller players in the domestic market of the host country cannot compete with.
All this results in the MNC having cheaper products and more visibility due to the higher amounts of advertising and have been known to push out smaller industries out of business. 4. Technology – Although, the MNCs have access to new and cutting edge technology, they do not transfer the latest technology to the host country with a fear that their home country may loose its competitive advantage. 2. Foreign Portfolio Investment (FPI) FPI is buying and selling of shares, convertible debentures of Indian companies and units of domestic mutual funds at any of the Indian stock exchanges.
FPI are done by foreign investors in shares, bonds and equity market. It brings foreign exchange to the country but it has its own problems as it brings volatile money to the country. Foreign Institutional Investors (FIIs) can make portfolio investments. FIIs are allowed to invest in the primary and secondary capital markets in India under the Portfolio Investment Scheme 3. Foreign Institutional Investment (FII) FII is defined as an institution established or incorporated outside India for making investment in Indian securities.
They may invest in securities traded in both the primary and secondary markets. These securities include shares, debentures, and units of mutual funds Foreign Institutional Investments are the investments by foreign financial institutes like banks, insurance companies, pension funds, mutual funds etc. These are mostly in Govt. securities which are quite secure. The entry and exit are very simple through FII’s. FIIs must register themselves with the Securities and Exchange Board of India (SEBI) and comply with the exchange control regulations of RBI. 4. External Commercial Borrowings (ECB)
ECB refer to commercial loans (in the form of bank loans, buyers’ credit, suppliers’ credit, securitised instruments) availed from non-resident lenders with minimum average maturity of 3 years. ECB for investment in real sector – industrial sector, especially infrastructure sector-in India, are under Automatic Route. ECB in the following requires approval of the government : a. Activities/items that require an Industrial Licence b. Proposals in which the foreign collaborator has an existing venture/tie up in India c. Proposals for acquisition of shares in an existing Indian company in some cases. . Depository Receipts (ADR/GDR) ADR is adopted by many large and well respected companies from India to raise funds from American Markets. If any Indian Company has issued ADRs in the American market wishes to further extend it to other developed and advanced countries such as Europe, then they can sell these ADRs to the public of Europe and the same would be named as GDR. ADRs and GDRs are not for investors in India – they can invest directly in the shares of various Indian companies. They are an excellent means of investment for NRIs and foreign nationals wanting to invest in India.
By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the Indian financial market – since ADRs and GDRs are traded like any other stock. NRIs and foreigners can buy these using their regular equity trading accounts. ------------------------------------------------- ROUTES OF ENTRY There are majorly two routes for entry in India – 1. Automatic Route : The route wherein no government approval is required for the investors. As a reference, FDI up to 100% is allowed in all activities/sectors. 2.
Approval Route : The route wherein Government approval is required. This is done by either RBI or FIPB. Apart, from two major classifications. There can also be other classification also as shown below – 1. As a foreign company through a Liaison Office/ Representative Office, Project Office or a Branch Office. 2. As an Indian company through a Joint Venture or a Wholly Owned Subsidiary. LIAISON OFFICE / REPRESENTATIVE OFFICE Foreign corporations/entities are permitted to open liaison offices/representative offices in India for undertaking liaison activities on their behalf. Approval from RBI is needed.
No fees, commission or remuneration can be charged by the Indian liaison office. Liaison office cannot directly or indirectly undertake any trading, commercial or manufacturing activity and therefore, cannot earn any income in India. Its role is limited - 1. to representing the parent company/group companies in India 2. promoting export/import from/to India 3. promoting collaborations between parent company and companies in India 4. collecting information about possible market opportunities and providing information about the company and its products to prospective Indian customers.
PROJECT OFFICE A foreign corporation, which has secured a contract from an Indian company to execute a project in India, is allowed to establish a project office in India without obtaining prior permission from RBI. Such offices cannot undertake or carry on any activity other than the activity relating to the execution of the project. The foreign corporation which sets up such a project office is required to furnish a prescribed report to the concerned regional office of RBI under whose jurisdiction the project office is set up.
BRANCH OFFICE Foreign corporations/entities engaged in manufacturing and trading activities abroad are allowed to set up branch offices in India. The branch office can carry the same activities as the ones carried on by the foreign corporation overseas except that it cannot carry manufacturing activity on its own (sub-contracting is permitted). It can also stock & sell products in India and is permitted to acquire immovable property necessary or incidental to carrying on activities permitted by RBI. Green field investment:-
A form of foreign direct investment where a parent company starts a new venture in a foreign country by constructing new operational facilities from the ground up. It occurs when multinational corporations enter into devolping countries to build new factories. Advantages:- Firm can build the subsidiary it wants. Relatively easily to establish operating routines. New jobs are created in the local market. Disadvantages:- Faces competition before it is set up Time consuming research has to be carried out before hand. Emerging markets might be unstable, hence leading to extra costs & time consumption. Lengthy process from scratch
Brown field investment:- The purchasing of an existing production or business facility by companies or governmental agencies for the purpose of starting new product or service production activity. This type of investment does not involved the new construction of plant operation facility. It is also called merger and acquisition. Advantages:- Less time consuming & quick to execute. Less risky as compared to greenfield. Immediate grab of market share. Reduce competition by taking over rival. The investor can bank on the existing goodwill of the acquired business. Disadvantages:- Not always successful.
Cultural clash reducing effectiveness. Some workers are laid off, this affects motivational levels of present workers JOINT VENTURE The cooperation of two or more individuals or businesses in which each agrees to share profit, loss and control in a specific enterprise. A Joint venture is a business agreement in which parties agree to develop, a new entity and new assets by contributing equity. The cooperation of two or more individuals or businesses in which each agrees to share profit, loss and control in a specific enterprise. Forming a joint venture is a good way for companies to partner without having to merge.
JV’S are typically taxed as a partnership. Advantages:- Help the company to grow in those areas where the company does not have any expertise and would have failed if it was not for joint venture. Joint venture can help the company in reducing the risks which are associated with starting a new business. It results in better utilization of the resources which company has at its disposal. Disadvantages:- It does not give the management of the company control because the decisions are taken by both the companies and therefore it can create problems if both companies do not agree on some issues.
It is difficult to integrate resources of companies entering into joint ventures WHOLLY – OWNED SUBSIDIARY A Foreign corporation can set up its subsidiary company either in the form of a private limited company or as a public limited company in India. A company in India is required to be incorporated under The Companies Act, 1956. In comparison with the branch office and liaison office, a subsidiary company provides maximum flexibility for conducting business in India. It can also undertake manufacturing activities in India
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